WASHINGTON - The Federal Reserve on Wednesday gave the green light to plans by major banks in the U.S. to raise their dividends and buy back shares, judging their financial foundations sturdy enough to withstand a major economic downturn. But the Fed rejected the plans put forward by the U.S. businesses of two European banks, Germany's Deutsche Bank (DB) and Spain's Santander (SAN).
Morgan Stanley's (MS) plan only got conditional approval, and the bank has until the end of the year to revise it. But the Wall Street institution was still allowed to return profits to shareholders, and it quickly announced plans to buy back up to $3.5 billion worth of its stock and to boost its dividend 33 percent.
As a result of its annual "stress tests," the Fed outright rejected plans by the U.S. division of Santander and by Deutsche Bank Trust Corp., the U.S. transaction bank and wealth management business of Germany's biggest bank. It was the third straight year that the Fed rejected the plan of Santander, which is one of the biggest banks in Europe, and the second straight rejection for Deutsche Bank. The regulators said, although there have been improvements, the banks continue to have weaknesses in supervision that could harm their capital planning.
The remaining 30 banks were allowed to raise dividends or repurchase shares. They include JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC), which are the four biggest U.S. banks by assets.
A number of banks quickly jumped in with announcements of share buyback plans. They included Bank of America ($5 billion) and Citigroup (up to $8.6 billion).
The stress tests are an annual checkup of the biggest financial institutions in the U.S. This was the sixth year of the tests. Thirty-three banks were tested to determine if they have large enough capital buffers to keep lending, even if faced with billions of dollars in losses in another financial crisis and severe economic downturn.
"The participating firms have strengthened their capital positions and improved their risk-management capacities," Fed Gov. Daniel Tarullo said in a statement. "Continued progress in both areas will further enhance the resiliency of the nation's largest banks."
The tests were mandated by Congress in the wake of the financial crisis that struck in 2008 and plunged the U.S. into the worst economic downturn since the Great Depression of the 1930s.
The announcement on the second round of the stress tests followed last week's initial results. The regulators determined that the 33 big banks hold more capital than at any time since the crisis and are adequately fortified to withstand a severe U.S. and global recession and continue lending.
Fed's most extreme hypothetical scenario in this year's tests envisions the U.S. economy falling into a deep recession, causing the stock market to plunge 50 percent. Unemployment climbs above 10 percent, while housing prices drop by 25 percent and commercial real estate prices tumble 30 percent. In this scenario, investors would be so panicked that yields on short-term U.S. Treasury securities would go negative -- meaning even the safest of assets would still lose money.
Beyond hypotheticals, big bank stocks took a huge hit from Britain's vote to leave the European Union last week. As a sector, their shares took the largest losses by far as stocks plunged in the U.S. and worldwide Friday, when results of the historic vote became known.
Stock prices have since recovered, but uncertainty remains. U.S. banks have a lot to lose in Britain's departure from the 28-nation bloc because they do a lot of cross-border business in Europe from their offices in London. They also become less profitable when bond yields fall, since that lowers interest rates on mortgages and many other kinds of loans.
Fed officials change the stress test scenarios each year to reflect the current economic climate around the world. This year's did include a severe recession in Britain and in the bloc of countries that use the euro currency -- but not a "Brexit," Britain's move to leave the EU.
The Fed said the 33 big banks would sustain $385 billion in loan losses under the most dire scenario. But even with those losses, all the banks would still together hold a high-quality capital ratio of 8.4 percent, well above the 4.5 percent minimum. Capital ratios are an industry measure of how strong a bank is.
The dividend increases and share buyback plans are important to ordinary investors, and to banks. The banks know their investors suffered big losses in the financial crisis, and they are eager to reward them. Some shareholders, especially retirees, rely on dividends for a portion of their income. For the banks, raising dividends can drive up their share prices and make their stock more valuable to investors.
But raising dividends is costly, and regulators don't want banks to deplete their capital reserves, making them vulnerable in another recession. Buybacks also are aimed at helping shareholders. By reducing the number of a company's outstanding shares, earnings per share can increase.